What Will Disqualify You from an FHA Loan?

The Federal Housing Administration (FHA) loan program is designed to help individuals and families achieve homeownership by offering more lenient qualification requirements compared to conventional loans. However, there are still certain criteria and guidelines outlined in the FHA Handbook 4000.1 that can disqualify an applicant from obtaining an FHA loan. Understanding these disqualifications can help potential borrowers better prepare for the application process and increase their chances of approval.

Credit Score and History

A key factor in FHA loan eligibility is the applicant's credit score and history. While the FHA allows for lower credit scores compared to conventional loans, there are minimum thresholds that must be met. Generally, a credit score of at least 580 is required to qualify for the minimum down payment of 3.5%. Applicants with credit scores between 500 and 579 may still qualify, but they will need to make a larger down payment of 10%.

Beyond the credit score, the applicant's credit history is also scrutinized. Significant derogatory credit events such as foreclosures, bankruptcies, or collections may disqualify an applicant. For instance, if an applicant has a foreclosure, they typically must wait three years from the date of the foreclosure to be eligible for an FHA loan. Similarly, a Chapter 7 bankruptcy requires a two-year waiting period after discharge, while a Chapter 13 bankruptcy requires at least one year of successful repayment under the bankruptcy plan.

Debt-to-Income Ratio

The debt-to-income (DTI) ratio is another critical factor in determining FHA loan eligibility. The DTI ratio compares the applicant's monthly debt payments to their gross monthly income. FHA guidelines generally require a front-end DTI ratio (housing expenses) of no more than 31% and a back-end DTI ratio (total monthly debt) of no more than 43%. However, in some cases, lenders may allow higher ratios if the borrower has compensating factors such as a large down payment, significant cash reserves, or a stable employment history.

Applicants with excessive debt or those who are unable to demonstrate their ability to manage monthly payments effectively may be disqualified based on their DTI ratio. It's crucial for potential borrowers to evaluate their financial situation and reduce debt levels before applying for an FHA loan.

Employment and Income Stability

Stable and reliable income is essential for FHA loan approval. Lenders typically require at least two years of consistent employment history in the same field or job. Frequent job changes or gaps in employment may raise red flags and lead to disqualification.

Additionally, the applicant's income must be verifiable and sufficient to cover the mortgage payments and other financial obligations. Self-employed individuals or those with irregular income streams may need to provide additional documentation, such as tax returns and profit-and-loss statements, to demonstrate income stability.

Property Requirements

The property being purchased with an FHA loan must meet specific standards outlined in the FHA Handbook 4000.1. The property must be the borrower's primary residence and meet minimum safety, security, and soundness standards. If the property fails to meet these requirements, it may be disqualified from FHA financing.

Some common property-related disqualifications include significant structural issues, pest infestations, or non-compliance with local building codes. Additionally, properties located in certain areas prone to natural disasters or environmental hazards may also be disqualified. You can't get an FHA loan if your home is located too near a busy street, too near high tension electrical tower, to name a couple of real life examples. 

FHA Loan Limits

FHA loans have established limits on the amount that can be borrowed, which vary by geographic location. These limits are determined based on the median home prices in each area. If the desired loan amount exceeds the FHA loan limit for the area, the applicant may be ineligible for an FHA loan.

Potential borrowers need to be aware of the FHA loan limits in their area and ensure that their desired loan amount falls within these limits.

Non-Occupancy of the Property

FHA loans are intended for primary residences, meaning you must live in the property as your main home. If you plan to use the property as a rental or secondary residence, you will not qualify for an FHA loan.

Failure to Meet Down Payment Requirements

The FHA requires a minimum down payment of 3.5% for those with credit scores of 580 or higher. If you cannot meet the down payment requirement, you may be disqualified from obtaining the loan.

Non-Eligible Citizenship Status

To qualify for an FHA loan, you must be a U.S. citizen, a permanent resident, or a non-permanent resident with a valid work permit. If you do not meet these criteria, you may be ineligible for an FHA loan.

Conclusion

While FHA loans offer a more accessible path to homeownership for many, certain factors can disqualify you from obtaining one. It is essential to understand these potential disqualifiers and address any issues before applying. By doing so, you can improve your chances of securing an FHA loan and achieving your homeownership goals.